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Here’s Why Some Huge Hedge Funds Think Oil Prices Could Plunge Again

Hedge funds have been liquidating their former record bullish position in crude futures and options putting downward pressure on oil prices in recent weeks.

But now the liquidation of old long positions is being replaced by the establishment of new short positions as fund managers try to capitalize on the downward cycle in prices.

Hedge funds and other money managers cut their net long position in Brent and WTI futures and options by 31 million barrels to 453 million in the week ending on July 19.

That’s down from 650 million in the middle of May, and 663 million at the end of April.

In the week to July 19, long positions actually rose by 5 million barrels as some funds sought buying opportunities after prices had been battered down.

But short positions increased by almost 36 million, as many more managers positioned themselves for a momentum-driven drop in prices coupled with mounting concerns about weakening demand fundamentals.

Hedge fund position building during the first five months of the year seems to have anticipated and accelerated a rise in prices that would most likely have occurred anyway as the physical oil market moved closer to balance.

Just as the accumulation of a large net long position helped propel prices higher sharply higher between January and May, the subsequent liquidation of part of that position has seen the rally stall and then go into reverse.

Hedge fund managers have anticipated the reaction by increasing short positions, especially in NYMEX WTI, designed to be profitable when prices dip.

Hedge funds increased their short positions in NYMEX WTI in five of the last seven weeks, according to data published by the U.S. Commodity Futures Trading Commission.

Short positions have almost tripled from 53 million barrels at the end of May to 141 million barrels on July 19 as prices have eased down from $50 to $45 per barrel.

Hedge funds have become more confident that the former rally is over as oil prices have failed to recover their previous peak of more than $50 per barrel.

And the emerging downtrend in oil prices has emboldened managers to increase their bearish bets on short-term oil prices.

The increase in hedge fund short positions in the week to July 19, equivalent to nearly 28 million barrels, was the largest one-week increase since July 2015.

Since the start of 2015, there has been a strong correlation between hedge fund short positions and WTI prices.

There have been three cycles of position building and liquidation in which hedge funds have accumulated and then reduced large short positions in WTI.

Now the hedge funds appear to have embarked on a fourth.